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The minutes of the RBA meeting on 4 July have been interpreted by many commentators as evidence that the RBA is looking to increase interest rates in the future. Rumours to this effect are premature.

If we just put aside the fact that inflation is lower than the target rate, that the two sectors driving the economy over the past decade – mining and housing – have finished their investment phases and measures of consumer confidence are less than inspiring, there is one other major factor impacting the Australian economy that will ward off increases in interest rates this year and perhaps in 2018 as well.

Rapidly rising energy prices will contribute to an increase in measures of inflation such as the Consumer Price Index. Signs of inflationary pressures would ordinarily be cause for the RBA to consider the need to tighten monetary policy. This time around they will need to pay much closer attention to the impact that sharply rising energy prices could be having in holding back demand elsewhere in the economy.

Electricity prices doubled as a result of an investment cycle in poles and wires caused by political decisions to improve reliability, a regulatory failure to recognise a fall in demand and poorly timed capital renewal. These were compounded by a range of government interventions in the market relating to renewable/carbon policies that undermined the investor certainty necessary for a capital intensive industry.

Gas prices are now skyrocketing because the Australian Government stimulated the demand for Australian gas at the same time as state governments acted to constrain the supply. Manufacturing facilities are reporting gas price increases of more than 50 per cent this year alone.

These rising energy prices impact on both manufacturing firms and households.

Businesses and households respond to rising energy costs in much the same way as they do to a rise in interest rates.

For families, it pushes up their bills. Households reduce their spending in other areas of the economy, travel, entertainment, and shopping in order to keep the lights on at home. It may also cause households to reevaluate debt serviceability and will impede the ability of first home buyers to enter the market as they struggle to save for their first home purchase.

Energy price rises hurt consumer confidence. With both electricity and gas prices rising households have limited capacity to substitute their energy demand and must reduce their household expenditure.

Rising energy prices also constrain business investment and limits Australia’s attractiveness as an investment destination. This has long-term negative impacts on employment which flows through to lower wage growth and has the potential to reduce inflationary pressure in the economy for years.

The hollowing out of the manufacturing sector that is currently underway is a significant concern for an economy that has worked for decades to build a wider and deeper economy that is not susceptible to commodity price cycles and weather conditions as the drivers for change.

The big difference between the impact of energy prices and interest rates in taking the inflationary heat out of the economy is that when conditions change, interest rates can be moved quickly.

The dramatic energy price increases that Australian households and business are, and will continue, to incur are going to be locked in for decades. They will continue to impeded household expenditure as well as holding back business investment, job creation and therefore wage growth.

To this end, elevated energy prices will continue to dampen wider inflationary pressures in the Australian economy. This could mean that the anticipated rate hike from the RBA is further away than some expect.

 
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